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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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(Mark One)

|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------

For the Quarterly Period Ended March 31, 2007

OR



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------

For the transition period from  to

Commission File Number: 000-50958



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CallWave Inc.

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                        
|-------------------------------------------------------------- |  | ---------------------------------------
|Delaware                                                       |  | 77-0490995                             
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification Number)

136 West Canon Perdido Street, Suite C, Santa Barbara, California 93101

(Address of principal executive offices)

(Zip code)

(805) 690-4100

(Registrants telephone number, including area code)



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Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No ̈

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2
of the Exchange Act (Check one):

Large Accelerated Filer ̈Accelerated Filer ̈Non-Accelerated Filer  x

Indicate by check mark whether the registrant is a
shell company (as defined in Rule 12b-2 of the Exchange Act)    Yes ̈No  x

At April 16, 2007, the number of shares outstanding of the registrants common stock, $0 par value, was
20,856,764.



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##### Table of Contents

CALLWAVE INC.

Form 10-Q

For the Quarter Ended March 31, 2007

INDEX



|        |  |                                                                                                                 |  |         
|------- |  | --------------------------------------------------------------------------------------------------------------- |  | --------
|        |  |                                                                                                                 |  | Page No.
|        |  | PART I. FINANCIAL INFORMATION                                                                                   |  | 1       
|Item 1  |  | Financial Statements                                                                                            |  | 1       
|        |  | Condensed Consolidated Balance SheetsMarch 31, 2007 (unaudited) and June 30, 2006                              |  | 1       
|        |  | Condensed Consolidated Statements of OperationsThree and Nine Months Ended March 31, 2007 and 2006 (unaudited) |  | 2       
|        |  | Condensed Consolidated Statements of Cash FlowsNine Months Ended March 31, 2007 and 2006 (unaudited)           |  | 3       
|        |  | Notes to Condensed Consolidated Financial Statements (unaudited)                                                |  | 4       
|Item 2  |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                           |  | 13      
|Item 3  |  | Quantitative and Qualitative Disclosures About Market Risk                                                      |  | 19      
|Item 4  |  | Controls and Procedures                                                                                         |  | 19      
|        |  |                                                                                                                
|        |  | PART II. OTHER INFORMATION                                                                                      |  | 20      
|Item 1  |  | Legal Proceedings                                                                                               |  | 20      
|Item 1A |  | Risk Factors                                                                                                    |  | 20      
|Item 2  |  | Unregistered Sales of Equity Securities and Use of Proceeds                                                     |  | 23      
|Item 3  |  | Defaults Upon Senior Securities                                                                                 |  | 23      
|Item 4  |  | Submission of Matters to a Vote of Security Holders                                                             |  | 23      
|Item 5  |  | Other Information                                                                                               |  | 23      
|Item 6  |  | Exhibits                                                                                                        |  | 23      
|        |  | Signatures                                                                                                      |  | 24      
|        |  | Certifications                                                                                                  |  |         



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##### Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CALLWAVE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except par value)



|                                                                                                                                                                                             |  |                    |         |   |                   |   |        |  
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------ | ------- | - | ----------------- | - | ------ | -
|                                                                                                                                                                                             |  | As ofMarch 31,2007 |         |   | As ofJune 30,2006 |  
|                                                                                                                                                                                             |  | (unaudited)        |         |   |                   |  
|Assets                                                                                                                                                                                       |  |                    |         |   |                   |   |        |  
|Current assets:                                                                                                                                                                              |  |                    |         |   |                   |   |        |  
|Cash and cash equivalents                                                                                                                                                                    |  | $                  | 19,464  |   |                   | $ | 24,040 |  
|Marketable securities                                                                                                                                                                        |  |                    | 35,939  |   |                   |   | 36,907 |  
|Accounts receivable; net of allowance for doubtful accounts of $472 and $574, respectively                                                                                                   |  |                    | 2,576   |   |                   |   | 2,834  |  
|Prepaid income tax                                                                                                                                                                           |  |                    | 88      |   |                   |   | 88     |  
|Other current assets                                                                                                                                                                         |  |                    | 884     |   |                   |   | 973    |  
|                                                                                                                                                                                             |  |                    |         |   |                   |   |        |  
|Total current assets                                                                                                                                                                         |  |                    | 58,951  |   |                   |   | 64,842 |  
|                                                                                                                                                                                             |  |                   
|Property and equipment, net                                                                                                                                                                  |  |                    | 2,163   |   |                   |   | 2,014  |  
|Intangible assets, net                                                                                                                                                                       |  |                    | 4,493   |   |                   |   | 533    |  
|Other assets                                                                                                                                                                                 |  |                    | 66      |   |                   |   | 66     |  
|                                                                                                                                                                                             |  |                    |         |   |                   |   |        |  
|Total assets                                                                                                                                                                                 |  | $                  | 65,673  |   |                   | $ | 67,455 |  
|                                                                                                                                                                                             |  |                    |         |   |                   |   |        |  
|                                                                                                                                                                                             |  |                   
|Liabilities And Stockholders' Equity                                                                                                                                                         |  |                    |         |   |                   |   |        |  
|Current liabilities:                                                                                                                                                                         |  |                    |         |   |                   |   |        |  
|Accounts payable                                                                                                                                                                             |  | $                  | 1,962   |   |                   | $ | 451    |  
|Accrued payroll                                                                                                                                                                              |  |                    | 1,104   |   |                   |   | 735    |  
|Deferred revenue                                                                                                                                                                             |  |                    | 847     |   |                   |   | 92     |  
|Other current liabilities                                                                                                                                                                    |  |                    | 1,278   |   |                   |   | 1,515  |  
|                                                                                                                                                                                             |  |                    |         |   |                   |   |        |  
|Total current liabilities                                                                                                                                                                    |  |                    | 5,191   |   |                   |   | 2,793  |  
|                                                                                                                                                                                             |  |                   
|Commitments and contingencies                                                                                                                                                                |  |                    |        |   |                   |   |       |  
|                                                                                                                                                                                             |  |                   
|Stockholders' equity:                                                                                                                                                                        |  |                    |         |   |                   |   |        |  
|Common stock, $0 par value; 100,000 shares authorized at March 31, 2007 and June 30, 2006; 20,844 and 20,800 shares issued and
outstanding at March 31, 2007 and June 30, 2006, respectively |  |                    | 72,993  |   |                   |   | 72,119 |  
|Accumulated comprehensive loss                                                                                                                                                               |  |                    | (11     | ) |                   |   | (143   | )
|Accumulated deficit                                                                                                                                                                          |  |                    | (12,500 | ) |                   |   | (7,314 | )
|                                                                                                                                                                                             |  |                    |         |   |                   |   |        |  
|Total stockholders equity                                                                                                                                                                   |  |                    | 60,482  |   |                   |   | 64,662 |  
|                                                                                                                                                                                             |  |                    |         |   |                   |   |        |  
|Total liabilities and stockholders equity                                                                                                                                                   |  | $                  | 65,673  |   |                   | $ | 67,455 |  
|                                                                                                                                                                                             |  |                    |         |   |                   |   |        |  

See accompanying notes



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##### Table of Contents

CALLWAVE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(unaudited)



|                                                  |  |                                     |        |   |                                    |   |        |      |  |   |        |   |  |   |        |  
|------------------------------------------------- |  | ----------------------------------- | ------ | - | ---------------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                  |  | For the Three MonthsEnded March 31, |        |   | For the Nine MonthsEnded March 31, |  
|                                                  |  | 2007                                |        |   | 2006                               |   |        | 2007 |  |   | 2006   |  
|Revenue                                           |  | $                                   | 6,230  |   |                                    | $ | 8,801  |      |  | $ | 19,673 |   |  | $ | 28,910 |  
|Cost of sales                                     |  |                                     | 2,257  |   |                                    |   | 3,125  |      |  |   | 6,676  |   |  |   | 10,275 |  
|                                                  |  |                                     |        |   |                                    |   |        |      |  |   |        |   |  |   |        |  
|Gross profit                                      |  |                                     | 3,973  |   |                                    |   | 5,676  |      |  |   | 12,997 |   |  |   | 18,635 |  
|Operating expenses (1):                           |  |                                     |        |   |                                    |   |        |      |  |   |        |   |  |   |        |  
|Sales and marketing                               |  |                                     | 2,347  |   |                                    |   | 1,770  |      |  |   | 5,381  |   |  |   | 4,802  |  
|Research and development                          |  |                                     | 1,857  |   |                                    |   | 1,687  |      |  |   | 5,266  |   |  |   | 5,031  |  
|General and administrative                        |  |                                     | 3,136  |   |                                    |   | 3,143  |      |  |   | 9,899  |   |  |   | 8,121  |  
|Impairment of long-lived assets                   |  |                                     |       |   |                                    |   |       |      |  |   |       |   |  |   | 243    |  
|                                                  |  |                                     |        |   |                                    |   |        |      |  |   |        |   |  |   |        |  
|Total operating expenses                          |  |                                     | 7,340  |   |                                    |   | 6,600  |      |  |   | 20,546 |   |  |   | 18,197 |  
|                                                  |  |                                     |        |   |                                    |   |        |      |  |   |        |   |  |   |        |  
|Operating income (loss)                           |  |                                     | (3,367 | ) |                                    |   | (924   | )    |  |   | (7,549 | ) |  |   | 438    |  
|Interest income                                   |  |                                     | 766    |   |                                    |   | 659    |      |  |   | 2,363  |   |  |   | 1,741  |  
|                                                  |  |                                     |        |   |                                    |   |        |      |  |   |        |   |  |   |        |  
|Income (loss) before income taxes                 |  |                                     | (2,601 | ) |                                    |   | (265   | )    |  |   | (5,186 | ) |  |   | 2,179  |  
|Income tax expense                                |  |                                     |       |   |                                    |   | 156    |      |  |   |       |   |  |   | 3,085  |  
|                                                  |  |                                     |        |   |                                    |   |        |      |  |   |        |   |  |   |        |  
|Net loss                                          |  | $                                   | (2,601 | ) |                                    | $ | (421   | )    |  | $ | (5,186 | ) |  | $ | (906   | )
|                                                  |  |                                     |        |   |                                    |   |        |      |  |   |        |   |  |   |        |  
|Net loss per share:                               |  |                                     |        |   |                                    |   |        |      |  |   |        |   |  |   |        |  
|Basic and diluted                                 |  | $                                   | (0.12  | ) |                                    | $ | (0.02  | )    |  | $ | (0.25  | ) |  | $ | (0.04  | )
|Weighted average common shares outstanding        |  |                                     |        |   |                                    |   |        |      |  |   |        |   |  |   |        |  
|Basic and diluted                                 |  |                                     | 20,830 |   |                                    |   | 20,746 |      |  |   | 20,815 |   |  |   | 20,578 |  
|                                                  |  |                                     |        |   |                                    |   |        |      |  |   |        |   |  |   |        |  
|(1) Includes stock-based compensation as follows: |  |                                     |        |   |                                    |   |        |      |  |   |        |   |  |   |        |  
|Sales and marketing                               |  | $                                   | 56     |   |                                    | $ | 17     |      |  | $ | 149    |   |  | $ | 81     |  
|Research and development                          |  |                                     | 82     |   |                                    |   | 37     |      |  |   | 248    |   |  |   | 103    |  
|General and administrative                        |  |                                     | 124    |   |                                    |   | 27     |      |  |   | 385    |   |  |   | 106    |  

See accompanying notes.



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CALLWAVE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)



|                                                                                          |  |                            |         |   |      |   |         |  
|----------------------------------------------------------------------------------------- |  | -------------------------- | ------- | - | ---- | - | ------- | -
|                                                                                          |  | Nine Months EndedMarch 31, |        
|                                                                                          |  | 2007                       |         |   | 2006 |  
|Cash flows from operating activities:                                                     |  |                            |         |   |      |   |         |  
|Net loss                                                                                  |  | $                          | (5,186  | ) |      | $ | (906    | )
|Adjustments to reconcile net loss to net cash provided by (used in) operating activities: |  |                            |         |   |      |   |         |  
|Depreciation and amortization                                                             |  |                            | 599     |   |      |   | 628     |  
|Impairment of long-lived assets                                                           |  |                            |        |   |      |   | 253     |  
|Stock based compensation                                                                  |  |                            | 782     |   |      |   | 290     |  
|Deferred income taxes                                                                     |  |                            |        |   |      |   | 2,929   |  
|Inventory writeoff                                                                        |  |                            |        |   |      |   | 314     |  
|Bad debt expense                                                                          |  |                            | 1,096   |   |      |   | 1,470   |  
|Net realized gain on sale of marketable securities                                        |  |                            | (24     | ) |      |   |        |  
|Loss on disposal of fixed assets                                                          |  |                            | 12      |   |      |   |        |  
|                                                                                          |  |                           
|Changes in operating assets and liabilities:                                              |  |                            |         |   |      |   |         |  
|Restricted cash                                                                           |  |                            |        |   |      |   | 336     |  
|Accounts receivable, net of bad debt expense                                              |  |                            | (838    | ) |      |   | 387     |  
|Inventory                                                                                 |  |                            |        |   |      |   | 140     |  
|Prepaid income taxes                                                                      |  |                            |        |   |      |   | (67     | )
|Other assets                                                                              |  |                            | 37      |   |      |   | 317     |  
|Accounts payable                                                                          |  |                            | 1,511   |   |      |   | 38      |  
|Accrued payroll and other liabilities                                                     |  |                            | 135     |   |      |   | 290     |  
|Deferred revenue                                                                          |  |                            | 755     |   |      |   | (1,300  | )
|Income taxes payable                                                                      |  |                            | (3      | ) |      |   |        |  
|                                                                                          |  |                            |         |   |      |   |         |  
|Net cash provided by (used in) operating activities                                       |  |                            | (1,124  | ) |      |   | 5,119   |  
|                                                                                          |  |                           
|Cash flows from investing activities:                                                     |  |                            |         |   |      |   |         |  
|Purchases of intangible assets                                                            |  |                            | (4,000  | ) |      |   | (550    | )
|Purchases of marketable securities                                                        |  |                            | (66,988 | ) |      |   | (25,575 | )
|Sales of marketable securities                                                            |  |                            | 68,112  |   |      |   | 23,790  |  
|Purchases of property and equipment                                                       |  |                            | (680    | ) |      |   | (373    | )
|                                                                                          |  |                            |         |   |      |   |         |  
|Net cash used in investing activities                                                     |  |                            | (3,556  | ) |      |   | (2,708  | )
|                                                                                          |  |                           
|Cash flows from financing activities:                                                     |  |                            |         |   |      |   |         |  
|Proceeds from exercises of stock options                                                  |  |                            | 104     |   |      |   | 1,361   |  
|                                                                                          |  |                            |         |   |      |   |         |  
|Net cash provided by financing activities                                                 |  |                            | 104     |   |      |   | 1,361   |  
|                                                                                          |  |                            |         |   |      |   |         |  
|                                                                                          |  |                           
|Net increase (decrease) in cash and cash equivalents                                      |  |                            | (4,576  | ) |      |   | 3,772   |  
|Cash and cash equivalents at beginning of the period                                      |  |                            | 24,040  |   |      |   | 16,828  |  
|                                                                                          |  |                            |         |   |      |   |         |  
|Cash and cash equivalents at end of the period                                            |  | $                          | 19,464  |   |      | $ | 20,600  |  
|                                                                                          |  |                            |         |   |      |   |         |  
|                                                                                          |  |                           
|Supplemental disclosures of cash flow information                                         |  |                            |         |   |      |   |         |  
|Cash paid for:                                                                            |  |                            |         |   |      |   |         |  
|Income taxes                                                                              |  | $                          |        |   |      | $ | 223     |  
|Non-cash investing activities:                                                            |  |                            |         |   |      |   |         |  
|Stock issued for purchase of property                                                     |  | $                          | 40      |   |      | $ |        |  

See accompanying notes.



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CALLWAVE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. The Company and Basis of Presentation

The accompanying condensed
consolidated financial statements of CallWave, Inc., and its wholly owned subsidiaries (CallWave, or the Company) have been prepared in conformity with accounting principles generally accepted in the United States and are consistent in
all material respects with those applied in the Companys annual report on Form 10-K for the year ended June 30, 2006. The preparation of condensed consolidated financial statements in conformity with U.S. generally accepted accounting
principles requires management to make estimates and judgments that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. Examples include the estimate of useful lives of property and equipment, the
valuation of stock-based compensation, the allowance for doubtful accounts, the fair value of investments and intangible assets, and the recognition and measurement of income tax assets and liabilities. The actual results experienced by the Company
may differ from managements estimates.

The interim financial information is unaudited, but reflects all normal recurring adjustments that are, in
the opinion of management, necessary to fairly present the information set forth therein. The interim financial statements should be read in conjunction with the audited financial statements and related notes included in the Companys 2006
annual report on Form 10-K filed with the Securities and Exchange Commission on September 27, 2006. Interim results are not necessarily indicative of the results for a full year.

Reclassifications In the Companys quarterly condensed financial statements for the interim periods within the year ended June 30, 2006, all of the costs associated with the Companys
customer care subdivision were grouped with sales and marketing on the condensed consolidated statements of operations. Since customer care is a subdivision of operations, and the Company has traditionally allocated operating costs across sales and
marketing, research and development, and general and administrative operating expenses, the Company included customer care with operations before making the allocation for the current period presentation. Prior periods have been changed to conform
to this presentation. The reclassification did not impact operating loss, net loss, working capital or net cash provided by (used in) operating activities as previously reported.

Principles of consolidationThe condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. Intercompany balances and transactions have been
eliminated.

Share-Based CompensationThe Company adopted SFAS 123(R), Share-Based Payment, using the
modified-prospective-transition-method as of July 1, 2005. Historically, the Company elected to account for employee stock compensation under the fair value method in accordance with SFAS 123, Accounting for Stock-Based Compensation, and
had reflected compensation expense related to the fair value of options issued to employees in the condensed consolidated statement of operations. See further discussion in Note 3.

Revenue recognitionThe Company earns revenues primarily from paid subscriber services and to a lesser extent, fees earned from local exchange carrier call termination access charges and the offering of
third-party products and services to subscribers.

The Company recognizes revenue in accordance with accounting principles generally accepted in the United
States and with Securities and Exchange Commission Staff Accounting Bulletin 104 (SAB 104),Revenue Recognition, which clarifies certain existing accounting principles for the timing of revenue recognition and classification of revenues in
the financial statements. Revenue is recognized beginning when there is persuasive evidence of an arrangement, delivery has occurred or services have been rendered, the fees are fixed and determinable and collection is reasonably assured. Subscriber
revenues consist mainly of monthly recurring subscription fees. Revenue is recognized ratably over the subscription period when the SAB 104 criteria are met. Revenues and associated expenses are deferred and recognized over the associated service
period. Associated expenses are deferred only to the extent of such deferred revenue. During the quarter ended September 30, 2006, the Company refined the assumptions used for the amortization of deferred revenue and the associated costs. The
effect on revenue of refining these assumptions, which was treated as a change in estimate in accordance with U.S. generally accepted accounting principles (GAAP), was a reduction in revenue of $594,000. These refined assumptions also
reduced cost of sales by $214,000 and increased net loss by $380,000, or $0.02 per share. The change in estimate relates to more timely and accurate information made available by the Companys third party billing provider.



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##### Table of Contents

CALLWAVE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)



In addition to the direct relationship that the Company has with the majority of its paid subscribers, CallWave also
has indirect relationship agreements with Internet service providers (ISPs) and other companies whereby those companies customers are offered a co-branded subscription service. When the agreement provides that CallWave is the party responsible
for providing the service, has control over the fees charged to customers and bears the credit risk, CallWave records the gross amount billed as revenue in accordance with Emerging Issues Task Force Issue No. 99-19 (EITF 99-19),Reporting
Revenues Gross as a Principal Versus Net as an Agent. When the agreement provides that CallWave receives a net payment from the co-branding partners based upon the number of their customers registered for CallWave services, the Company records
the net amount received as revenue in accordance with EITF 99-19.

In the third quarter of fiscal 2005, the Company purchased prepaid phones and phone
cards with the intention of reselling them with a 30-day free trial of application-based services and the Company entered into an agreement to sell the prepaid phones and a portion of the phone cards to a distributor. Revenue from the sale of
prepaid phones and phone cards was recognized when the SAB 104 criteria were met. The Company recognized sales to distributors on a sell-through basis when the cash was collected from the distributor and had recognized $17,000 and $225,000 of
revenue related to sales to this distributor in the nine months ended March 31, 2007 and 2006, respectively. These transactions contain multiple elements, including the phone, the minutes, and the CallWave service, to which the Company has
applied EITF 00-21,Revenue Arrangements with Multiple Deliverables. The various elements of the arrangement are separable and each element is recognized separately in accordance with SAB 104. In accounting for multiple deliverables,
managements judgment is necessary when identifying the nature of deliverables in an arrangement as well as measuring and allocating fair value to the multiple deliverables. This program was cancelled in December of 2005.

Deferred revenueDeferred revenue consists of customer prepayments of subscription fees, which will be earned in the future under agreements existing at the
balance sheet date. Deferred revenue is amortized ratably over the period in which services are provided. Associated costs, such as billing fees, are deferred and recognized over the same period. In addition, install fees and up front non-recurring
engineering fees are recorded as deferred revenues and amortized to revenue over the expected period of performance, or the estimated average customer subscription life.

Cost of salesCost of sales consists of billing and collection costs, long-distance telephone service expenses used to deliver the Companys services and systems and telecommunications infrastructure.
The cost of phone cards and prepaid phones sold to a distributor is charged to cost of sales in the same period the revenue is recognized on the sell-through method. The cost of phones shipped to end users is charged to cost of sales when shipped to
the customer in accordance with EITF 01-9,Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendors Products). The cost of replacement phones expected to be shipped to customers who receive a
defective phone is accrued and charged to cost of sales. The cost of shipping and handling the phones and phone cards is directly charged to cost of sales.

Comprehensive net lossComprehensive net loss was $5,055,000 and $985,000 for the nine months ended March 31, 2007 and 2006, respectively. The comprehensive net loss differs from the net loss by the net unrealized gain or
loss on short-term investments.

Software development costsCosts of software developed to be sold or licensed to the external market are
accounted for under Statement of Financial Accounting Standards (SFAS) No. 86,Accounting for the Costs of Computer Software to Be Sold, Leased or Otherwise Marketed. Under SFAS 86, the Company expenses the costs of research, including
pre-development efforts prior to establishing technological feasibility, and costs incurred for training and maintenance. Software development costs are capitalized when technological feasibility has been established and anticipated future revenues
assure recovery of the capitalized amounts. Because of the relatively short time period between technological feasibility and product release, and the insignificant amount of cost incurred during such period, the Company has not capitalized any
software development costs to date.

InventoriesInventories consist of finished goods and are stated at the lower of cost or market, cost
being determined under the first-in, first-out method. During the nine months ended March 31, 2006, the Company recorded impairment of $314,000 against the entire inventory to reduce the balance to its net realizable value of $0.
Managements judgment is required in determining net realizable value and the extent of any impairment to inventory.



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CALLWAVE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)



Impairment of long-lived assetsThe Company accounts for the impairment and disposition of long-lived
assets in accordance with SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets. In accordance with SFAS No. 144, long-lived assets are reviewed for impairment whenever events or changes in circumstances
indicate that the carrying value of an asset may not be recoverable. Recoverability of assets to be held and used is measured by comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such
assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets.

Cash equivalentsAll highly liquid investments with original maturities of three months or less at date of purchase are considered to be cash equivalents.

Marketable securitiesMarketable securities consist of investment grade government agency and corporate debt securities. Investments with maturities beyond
one year are classified as short-term based on their highly liquid nature and because such investments represent the investment of cash that is available for current operations. All investments are classified as available-for-sale and are recorded
at estimated fair value. Unrealized gains and losses are reflected in other comprehensive loss. Held to maturity investments are carried at cost until they are sold or there is evidence that changes in the business environment or other facts and
circumstances suggest the investment may be other than temporarily impaired based on criteria outlined in FASB Staff Position Nos. FAS 115-1 and FAS 124-1 and on EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and its
Application to Certain Investments.

Income taxesIncome taxes are recorded in accordance with SFAS No. 109,Accounting for Income
Taxes. SFAS No. 109 requires the recognition of deferred tax assets and liabilities to reflect the future tax consequences of events that have been recognized in the Companys financial statements or tax returns. Measurement of the
deferred items is based on enacted tax laws. In the event the future consequences of differences between financial reporting bases and tax bases of the Companys assets and liabilities result in a deferred tax asset, SFAS 109 requires an
evaluation of the probability of being able to realize the future benefits indicated by such assets. A valuation allowance related to a deferred tax asset is recorded when it is more likely than not that some portion or the entire deferred tax asset
will not be realized.

Investments in minority owned companiesThe Company accounts for investments in minority interests of other companies
over which it does not exercise significant influence on the cost method in accordance with APB 18, The Equity Method of Accounting for Investments in Common Stock. Under the cost method, an investment is carried at cost until it is sold
or there is evidence that changes in the business environment or other facts and circumstances suggest it may be other than temporarily impaired based on criteria outlined in FASB Staff Position Nos. FAS 115-1 and FAS 124-1 and on EITF Issue
No. 03-1, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments.

Valuation of acquired intangible
assetsIntangible assets are accounted for under SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 142 requires the Company to record intangible assets at their fair value. Historically, the Company has used
the cash purchase price at the time of acquisition as the best indicator of fair value. SFAS No. 142 also requires the Company to periodically evaluate the carrying value of intangible assets to determine if an impairment loss should be
recorded under SFAS No. 142. In accordance with SFAS No. 142, an impairment loss shall be recognized if the carrying amount of an intangible asset is not recoverable and its carrying amount exceeds its fair value.

Concentrations of credit riskThe Company has a concentration of credit risk from an agreement with a vendor for billing and collection services provided for
a portion of the Companys paid users. The Company would be subject to sustaining a loss relative to its current receivable balance if the vendor failed to perform under the terms of the agreement. The receivable from the vendor at
March 31, 2007 and June 30, 2006 was $2,093,000 and $2,385,000, respectively.



6



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##### Table of Contents

CALLWAVE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)



Net loss per shareThe Company computes net loss per share in accordance with SFAS No. 128,Earnings per Share. Under the provisions of SFAS No. 128, basic net loss per share is computed using the weighted-average number of common shares outstanding during the period. Diluted net loss per share is computed using the
weighted-average number of common shares and, if dilutive, potential common shares outstanding during the period. Potential common shares consist of shares issuable upon exercise of stock options and warrants and conversion of convertible preferred
stock. The dilutive effect of outstanding stock options and warrants is reflected in diluted loss per share by application of the treasury stock method. Convertible preferred stock is reflected on an if-converted basis.

The following table sets forth the computation of basic and diluted net loss per share:



|                                                                   |  |                                                 |        |   |                            |   |        |      |  |   |        |   |  |   |        |  
|------------------------------------------------------------------ |  | ----------------------------------------------- | ------ | - | -------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                                   |  | Three Months Ended March 31,                    |        |   | Nine Months EndedMarch 31, |  
|                                                                   |  | 2007                                            |        |   | 2006                       |   |        | 2007 |  |   | 2006   |  
|                                                                   |  | (unaudited, in thousands except per share data) |       
|Basic and diluted net loss per share:                              |  |                                                 |        |   |                            |   |        |      |  |   |        |   |  |   |        |  
|Net loss attributable to common stockholders                       |  | $                                               | (2,601 | ) |                            | $ | (421   | )    |  | $ | (5,186 | ) |  | $ | (906   | )
|                                                                   |  |                                                 |        |   |                            |   |        |      |  |   |        |   |  |   |        |  
|Weighted-average common shares outstanding                         |  |                                                 | 20,830 |   |                            |   | 20,746 |      |  |   | 20,815 |   |  |   | 20,578 |  
|Effect of dilutive securities:                                     |  |                                                 |        |   |                            |   |        |      |  |   |        |   |  |   |        |  
|Stock options and warrants                                         |  |                                                 |       |   |                            |   |       |      |  |   |       |   |  |   |       |  
|Convertible preferred shares                                       |  |                                                 |       |   |                            |   |       |      |  |   |       |   |  |   |       |  
|                                                                   |  |                                                 |        |   |                            |   |        |      |  |   |        |   |  |   |        |  
|Weighted-average common shares outstanding for diluted calculation |  |                                                 | 20,830 |   |                            |   | 20,746 |      |  |   | 20,815 |   |  |   | 20,578 |  
|                                                                   |  |                                                 |        |   |                            |   |        |      |  |   |        |   |  |   |        |  
|Net loss per share:                                                |  |                                                 |        |   |                            |   |        |      |  |   |        |   |  |   |        |  
|Basic and diluted                                                  |  | $                                               | (0.12  | ) |                            | $ | (0.02  | )    |  | $ | (0.25  | ) |  | $ | (0.04  | )

Options to purchase 3,471,000 shares and warrants to purchase 120,000 shares were outstanding at March 31,
2007. These options and warrants were excluded from the computation of diluted earnings per share because their effect would be anti-dilutive due to the current period net loss. At March 31, 2006, options to purchase 508,000 shares with
exercise prices equal to or greater than the average fair value of common stock were outstanding. These options were also excluded from the respective computations of diluted earnings per share because their effect would be anti-dilutive.

2. Stockholders Equity

Common Stock

As of March 31, 2007, the Company is authorized to issue 100,000,000 shares of common stock. As of March 31, 2007, a total of 3,591,000
shares of common stock are reserved for issued and outstanding warrants for the purchase of 120,000 shares and issued and outstanding stock options for the purchase of 3,471,000 shares.

Warrants

As of June 30, 2006 and March 31, 2007, the Company has issued and outstanding warrants to
purchase up to 120,000 shares of common stock at exercise prices ranging from $0.55 to $4.00. No warrants were exercised during the nine months ended March 31, 2007.



7



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##### Table of Contents

CALLWAVE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)



3. Share-Based Payments

As of March 31, 2007, the Companys stock option plans consist of the 2004 Option Plan, the 2000 Option Plan and the 1999 Option Plan. The maximum shares issuable under these plans at March 31, 2007, consist of 3,729,922
shares, 2,250,000 shares and 1,350,000 shares authorized, respectively, of which options for 2,367,255 shares, 841,604 shares, and 262,090 shares are outstanding under the 2004, 2000 and 1999 Option Plans, respectively.

The Companys Board of Directors grants options at an exercise price equal to the fair market value of the Companys common stock at the date on which the
grant is approved by the Board. Stock option grants under the 2000 and 1999 Option Plans generally have a term of ten years from the date on which the grant is approved by the Board and option grants under the 2004 Plan generally have a term of five
years from the date on which the grant is approved by the Board of Directors. Vesting terms for most options are one-eighth after six months, and one-forty-eighth per month thereafter, becoming fully vested in four years.

The Company accounts for stock-based compensation in accordance with the provision of SFAS No. 123 (Revised 2004), Share-Based Payment (SFAS No. 123R).
Under the fair value recognition provision of SFAS No. 123R, stock-based compensation cost is estimated at the grant date based on the fair value of the award. The fair value of stock options granted is estimated using the Black-Scholes-Merton
option pricing model and a single option award approach. The fair value is amortized on a straight-line basis over the requisite service period of the awards, which is generally the vesting period.

Determining the appropriate fair value of stock-based awards at the grant date requires judgment, including estimating stock price volatility, forfeiture rates and
expected term. The Company computes expected volatility based on a combination of both historical volatility and market-based implied volatility, as management believes that the combination provides a more accurate estimate of future volatility. The
expected term represents the period of time that the stock-based awards are expected to be outstanding and is determined based on historical experience of similar awards. For the three and nine month periods ended March 31, 2007, expected
forfeitures were based on historical experience per department. For the three and nine month periods ended March 31, 2006, expected forfeitures were based on a Company-wide historical average. Due to the inherent uncertainty in valuing awards
for publicly-traded stock as of the grant date, given that such awards will be exercised, purchased or sold at indeterminate future dates, the actual value realized by the recipients, if any, may vary significantly from the value of the awards
estimated at the grant date.



|                                                     |  |                             |        |                            |   |       |  |      |            |  |   |      
|---------------------------------------------------- |  | --------------------------- | ------ | -------------------------- | - | ----- |  | ---- | ---------- |  | - | -----
|                                                     |  | Three Months EndedMarch 31, |        | Nine Months EndedMarch 31,
|                                                     |  | 2007                        |        | 2006                       |   | 2007  |  | 2006
|Weighted average fair value of stock options granted |  | $                           | 1.47   |                            | $ | 4.73  |  | $    | 1.44       |  | $ | 4.47 
|Risk free interest rate                              |  |                             | 4.82%  |                            |   | 4.60% |  |      | 4.57-4.95% |  |   | 3.89%
|Expected life (in years)                             |  |                             | 4.0    |                            |   | 4.0   |  |      | 4.0        |  |   | 4.0  
|Expected volatility                                  |  |                             | 56%    |                            |   | 50%   |  |      | 53%-58%    |  |   | 50%  
|Expected dividend yield                              |  |                             | 0.00%  |                            |   | 0.00% |  |      | 0.00%      |  |   | 0.00%
|Expected forfeiture rate                             |  |                             | 6%-48% |                            |   | 27%   |  |      | 2%-68%     |  |   | 27%  



8



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##### Table of Contents

CALLWAVE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)



A summary of option activity under the Option Plans as of March 31, 2007, and changes during the nine months
then ended is presented below:



|                                  |  |           |   |  |                               |      |                                          |      |                               |   |    
|--------------------------------- |  | --------- | - |  | ----------------------------- | ---- | ---------------------------------------- | ---- | ----------------------------- | - | ---
|Options                           |  | Shares    |   |  | Weighted-AverageExercisePrice |      | Weighted-AverageRemainingContractualTerm |      | AggregateIntrinsicValue($000)
|Outstanding at July 1, 2006       |  | 2,427,318 |   |  | $                             | 3.88 |                                          |      |                               |   |    
|Granted                           |  | 814,058   |   |  |                               | 3.30 |                                          |      |                               |   |    
|Exercised                         |  | (2,825    | ) |  |                               | 2.06 |                                          |      |                               |   |    
|Forfeited or expired              |  | (62,611   | ) |  |                               | 5.18 |                                          |      |                               |   |    
|                                  |  |           |   |  |                               |      |                                          |      |                               |   |    
|                                  |  |           |   | 
|Outstanding at September 30, 2006 |  | 3,175,940 |   |  |                               | 3.71 |                                          |      |                               |   |    
|Granted                           |  | 448,500   |   |  |                               | 2.65 |                                          |      |                               |   |    
|Exercised                         |  | (12,350   | ) |  |                               | 1.13 |                                          |      |                               |   |    
|Forfeited or expired              |  | (178,993  | ) |  |                               | 4.96 |                                          |      |                               |   |    
|                                  |  |           |   |  |                               |      |                                          |      |                               |   |    
|                                  |  |           |   | 
|Outstanding at December 31, 2006  |  | 3,433,097 |   |  |                               | 3.51 |                                          |      |                               |   |    
|Granted                           |  | 103,150   |   |  |                               | 3.09 |                                          |      |                               |   |    
|Exercised                         |  | (13,925   | ) |  |                               | 2.36 |                                          |      |                               |   |    
|Forfeited or expired              |  | (51,373   | ) |  |                               | 4.75 |                                          |      |                               |   |    
|                                  |  |           |   |  |                               |      |                                          |      |                               |   |    
|                                  |  |           |   | 
|Outstanding at March 31, 2007     |  | 3,470,949 |   |  | $                             | 3.49 |                                          | 5.02 |                               | $ | 866
|                                  |  |           |   |  |                               |      |                                          |      |                               |   |    
|                                  |  |           |   | 
|Exercisable at March 31, 2007     |  | 1,604,793 |   |  | $                             | 3.45 |                                          | 5.01 |                               | $ | 750
|                                  |  |           |   |  |                               |      |                                          |      |                               |   |    

The aggregate intrinsic value in the table above represents the total pretax intrinsic value (the difference
between the Companys closing stock price on the last trading day of the quarter ended March 31, 2007 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all
option holders exercised their options on March 31, 2007. This amount changes based on the fair market value of the Companys common stock. The total intrinsic value of options exercised during the nine months ended March 31, 2007 and
2006 was $27,000 and $111,000, respectively.

As of March 31, 2007, there was $3.4 million of total unrecognized compensation cost related to unvested
share-based compensation arrangements granted under the Option Plans. That cost is expected to be recognized over a weighted-average period of 2.83 years.

Total share-based compensation expense recognized for the nine months ended March 31, 2007 and 2006 was $782,000 and $290,000, respectively. For stock option awards subject to graded vesting we recognize compensation cost on a
straight-line basis over the service period for the entire award.



9



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##### Table of Contents

CALLWAVE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)



4. Commitments and Contingencies

Leases

The Company leases office space and certain office equipment under non-cancelable operating leases. Rental
expense under operating lease agreements was $171,000 and $169,000 for the three months ended March 31, 2007 and 2006, respectively, and $508,000 and $392,000 for the nine months ended March 31, 2007 and 2006, respectively.

Future minimum commitments remaining under these agreements as of March 31, 2007, are as follows:



|                               |  |                   |    
|------------------------------ |  | ----------------- | ---
|Twelve Months Ending March 31: |  | MinimumCommitment
|                               |  | (in thousands)   
|2008                           |  | $                 | 620
|2009                           |  |                   | 485
|2010                           |  |                   | 441
|2011                           |  |                   | 145

Franchise Tax Board Audit

In May 2006, the Company was notified by the California Franchise Tax Board that its research and development credits for the taxable year ended June 30, 2004, would be under examination. As of the date of this
filing, the examination is nearing completion. The Franchise Tax Board has recommended a reduction of the carryforward research credits by approximately $325,000. The Company intends to appeal the recommendation. Due to the valuation allowance
recorded against the Companys deferred tax assets, the reduction of the credit carryforward will not affect the Companys income tax provision, net loss, or net loss per share.

Internal Revenue Service Audit

In October 2006, the Company was
notified by the Internal Revenue Service that our income tax return for the year ended June 30, 2004, would be under examination. As of the date of this filing, the examination is nearing completion and management does not expect a material
adjustment.

Other Commitments and Contingencies

The
Company has long-distance service agreements with six carriers. As of March 31, 2007, minimum obligations under these agreements due within one year total $457,000. However, the Company expects to maintain some form of long-distance service
agreements indefinitely, and will likely assume similar obligations following the expiration of these agreements. As of March 31, 2007, minimum obligations due within one year under agreements with providers of billing and collection services
and outsourced customer support total $456,000.

See Note 7 for a discussion of legal contingencies.

5. Investment in Minority Owned Company

On January 6, 2005, the
Company acquired a minority interest in a UK company (the Investee) for $125,000 which was recorded on the cost method of accounting for investments in accordance with APB 18, The Equity Method of Accounting for Investments in Common Stock.
Additionally, the Investee issued to the Company a $125,000 promissory note due January 6, 2011. The promissory note is convertible into common stock in certain circumstances and bears interest at 4% per year, compounded monthly. The
Company also purchased a license to the Investees technology for five years for $125,000, which was amortized to expense over the life of the license. A total of $375,000 was recorded as Other Assets. At September 30, 2005, the Company
determined that the investment in and receivable from the Investee was other than temporarily impaired and recorded an impairment loss in the amount of $253,000. At December 31, 2005, the Company wrote off the remaining unamortized cost of the
license in the amount of $106,000 to research and development expense as it decided not to pursue use of the license.



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##### Table of Contents

CALLWAVE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)



6. Income Taxes

The provision for income taxes consists of the following for each of the periods ended:



|                          |  |                             |   |                           |   |      |  |      |   |  |   |      
|------------------------- |  | --------------------------- | - | ------------------------- | - | ---- |  | ---- | - |  | - | -----
|                          |  | Three Months EndedMarch 31, |   | Nine MonthsEndedMarch 31,
|                          |  | 2007                        |   | 2006                      |   | 2007 |  | 2006
|Current federal provision |  | $                           |  |                           | $ | 103  |  | $    |  |  | $ | 102  
|Current state             |  |                             |  |                           |   | 53   |  |      |  |  |   | 54   
|Deferred                  |  |                             |  |                           |   |     |  |      |  |  |   | 2,929
|                          |  |                             |   |                           |   |      |  |      |   |  |   |      
|                          |  | $                           |  |                           | $ | 156  |  | $    |  |  | $ | 3,085
|                          |  |                             |   |                           |   |      |  |      |   |  |   |      

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not
that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during periods in which temporary differences and net operating losses
become deductible and tax credits become usable. Due to the uncertainty surrounding the timing of realizing the benefits of its favorable tax attributes in future tax returns, the Company has placed a valuation allowance against its otherwise
recognizable deferred tax assets. The net increase in the valuation allowance for the nine months ended March 31, 2007, was approximately $1.6 million due to managements determination that it is more likely than not that the deferred tax
asset will not be realized.

As of March 31, 2007, the Company has cumulative net operating loss carryforwards for federal and California income tax
purposes of approximately $10.7 million and $23.2 million respectively. The losses begin to expire in fiscal year 2010. In addition, the Company has available tax credit carryforwards of approximately $2.1 million and $0.8 million for federal and
California tax purposes, respectively. The federal tax credits begin to expire in 2009. California tax credits can be carried over indefinitely.

7.
Litigation

As most recently reported in the Quarterly Report on Form 10-Q for the quarter ended December 31, 2006, as filed on February 13,
2007, CallWave was involved in a dispute with Catch Curve, Inc., a Delaware corporation, and j2 Global Communications, a Delaware corporation (collectively j2 Global). The matters concerned allegations that CallWaves operations
infringed certain patents of j2 Global, and were the subject of two actions pending in the United States District Court for the Central District of California (Action Nos. 04-7068 and 05-4819).

Effective March 13, 2007, CallWave and j2 Global entered into a Patent License and Settlement Agreement (the Agreement). Under the terms of the
Agreement, CallWave and j2 Global agreed to resolve all of j2 Globals outstanding patent infringement claims. CallWave has agreed to pay $4 million to j2 Global for a fully paid-up, nonexclusive license to use the Licensed Patents (as that
term is defined in the Agreement) for non-fax services. In addition, CallWave will pay a running royalty of at least 10% for a non-exclusive license to use the Licensed Patents for fax services. CallWave and j2 Global have agreed to dismiss all
pending litigation.

The $4 million license was recorded as an intangible asset and will be amortized over 13 years, the remaining life of the licensed
patents.



11



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##### Table of Contents

CALLWAVE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)



8. Recent Accounting Pronouncements

In March 2006, the FASB issued FIN No. 48, Accounting for Uncertainty in Income Taxes  an interpretation of FASB Statement No. 109, which clarifies the accounting for uncertainty in income
taxes recognized in an enterprises financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. This Interpretation prescribes a threshold for the financial statement recognition and measurement
of a tax position taken or expected to be taken in a tax return. The Interpretation also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The effective date of
this interpretation is the first fiscal year that begins after December 15, 2006. Management is currently evaluating the impact FIN 48 will have on the Companys financial statements.

In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (SFAS No. 157). This standard clarifies the principle that fair value should be based on the assumptions that market participants would use when pricing an asset or liability. Additionally, it establishes a fair value hierarchy that
prioritizes the information used to develop those assumptions. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. Management does not expect SFAS No. 157 to have a material
impact on the Companys financial condition or results of operations.

In September 2006, the FASB issued Statement of Financial Accounting Standards
No. 158,  Employers Accounting for Defined Benefit Pension and Other Postretirement Plans an amendment of FASB Statements No. 87, 88, 106, and 132(R) (SFAS No. 158). This standard requires employers to
recognize the underfunded or overfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in the funded status in the year in which the changes occur through
accumulated other comprehensive income. Additionally, SFAS No. 158 requires employers to measure the funded status of a plan as of the date of its year-end statement of financial position. The new reporting requirements and related new footnote
disclosure rules of SFAS No. 158 are effective for fiscal years ending after December 15, 2006. The new measurement date requirement applies for fiscal years ending after December 15, 2008. Management does not expect SFAS No.158
to have a material impact on the Companys financial condition or results of operations.

In September 2006, the SEC issued Staff Accounting Bulletin
(SAB) No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements, providing guidance on how prior year misstatements should be taken into consideration
when quantifying misstatements in current year financial statements for purposes of determining whether the current years financial statements are materially misstated. SAB No. 108 is effective for fiscal years ending on or after
November 15, 2006, and accordingly, the Company has adopted SAB No. 108 beginning in fiscal year 2007. The adoption of SAB 108 did not have an impact on the Companys financial condition or results of operations.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and LiabilitiesIncluding an amendment of FASB Statement
No. 115(SFAS 159).SFAS 159 permits entities to choose to measure certain financial assets and liabilities at fair value (the fair value option). Unrealized gains and losses, arising subsequent to adoption,
are reported in earnings. Management does not expect SFAS No. 159 to have a material impact on the Companys financial condition or results of operations.



12



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##### Table of Contents

|ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- | -------------------------------------------------------------------------------------

SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS

This quarterly report contains
forward-looking statements that include information relating to future events, future financial performance, strategies, expectations, competitive environment, regulation and availability of resources. These forward-looking statements
include, without limitation, statements regarding: proposed new applications and services; development of additional strategic relationships; our market opportunity; our strategy; our expectations concerning litigation, regulatory developments or
other matters; statements concerning projections, predictions, expectations, estimates or forecasts for our business, financial and operating results and future economic performance; statements of managements goals and objectives; and other
similar expressions concerning matters that are not historical facts. Words such as may, will, should, could, would, predicts, potential, continue,
expects, anticipates, future, intends, plans, believes, estimates, and similar expressions, as well as statements in future tense, identify forward-looking
statements.

Forward-looking statements should not be read as a guarantee of future performance or results, and will not necessarily be accurate
indications of the times at, or by which, that performance or those results will be achieved. Forward-looking statements are based on information available at the time they are made and managements good faith belief as of that time with
respect to future events, and are subject to risks and uncertainties that could cause actual performance or results to differ materially from those expressed in or suggested by the forward-looking statements. Important factors that could cause these
differences include, but are not limited to:



| |  |  | our ability to maintain and expand our user base;
| | - |  | -------------------------------------------------



| |  |  | industry competition;
| | - |  | ---------------------



| |  |  | our ability to continue to execute our growth strategies in the carrier and direct to consumer channels;
| | - |  | --------------------------------------------------------------------------------------------------------



| |  |  | our ability to build alternative, cost effective direct to consumer distribution channels;
| | - |  | ------------------------------------------------------------------------------------------



| |  |  | our ability to attract subscribers and generate revenues through new products and Web 2.0 technology;
| | - |  | -----------------------------------------------------------------------------------------------------



| |  |  | litigation, legislation, regulation or technological developments affecting our business;
| | - |  | -----------------------------------------------------------------------------------------



| |  |  | general economic conditions; and
| | - |  | --------------------------------



| |  |  | other factors discussed in the sections titled Risk Factors, Managements Discussion and Analysis of Financial Condition and Results of
Operations, and Business.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------

Forward-looking statements speak only as of the date they are made. You should not put undue
reliance on any forward-looking statements. We assume no obligation to update forward-looking statements to reflect actual results, changes in assumptions or changes in other factors affecting forward-looking information, except to the extent
required by applicable securities law. If we do update one or more forward-looking statements, no inference should be drawn that we will make additional updates with respect to those or other forward-looking statements.

Overview

We are working to realign our business focus to take
advantage of three important trends in the telecommunication industry:



| |  |  | the convergence of landline, mobile, and Internet communications.
| | - |  | -----------------------------------------------------------------



| |  |  | the acceleration in the adoption of Professionally Managed Outsourced services and applications.
| | - |  | ------------------------------------------------------------------------------------------------



| |  |  | the emergence of Web 2.0 technology.
| | - |  | ------------------------------------

For service
providers, these trends continue to drive the need for flexible, faster-to-market, network independent software applications to compete against competitive threats. In response, we are moving to complement our direct-to-consumer business model
with a Professionally Managed Outsourced application model to provide communication solutions that require minimal allocation of capital and allow service providers to quickly react to customer needs and adapt to the dynamically shifting competitive
landscape. For our direct-to-consumer business, these trends present opportunities for faster iteration of voice and text products and new channels for distribution, such as web-based galleries.

We provide application services on a subscription basis that add features and enhanced functionality to the telecommunications services used by mainstream consumers as
well as small and home offices. Our software-based services are delivered by our desktop Phone Companion Software (PCS) through our proprietary Enhanced Services Platform, which allows subscribers to manage calls across existing landline, mobile and
Internet networks. As of March 31, 2007, we had approximately 637,000 paying subscribers for these application services. Because our services improve the utilization of existing telecommunications services by our subscribers, we believe that
our application services complement the efforts of landline, mobile and Internet service providers to reduce their subscriber churn. This has allowed us to establish cooperative relationships with network service providers.



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Critical Accounting Policies and the Use of Estimates

Our discussion and analysis of our financial condition and results of operations is based upon our Condensed Consolidated Financial Statements, which have been prepared
in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to revenue recognition, allowances for doubtful accounts, accounting for income taxes, loss contingencies, stock-based
compensation, and valuation of acquired intangible assets. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates. We believe the following critical accounting policies affect our more significant
judgments and estimates used in the preparation of our Condensed Consolidated Financial Statements. Management has discussed the development and selection of the following critical accounting policies, estimates and assumptions with the Audit
Committee of our Board of Directors and the Audit Committee has reviewed these disclosures.

Revenue recognition.

We earn revenues primarily from paid subscriber services and, to a lesser extent, from local exchange carrier call termination access charges and the offering of
third-party products and services to our subscribers.

We recognize revenue in accordance with accounting principles generally accepted in the United
States and with Securities and Exchange Commission Staff Accounting Bulletin 104 (SAB 104),Revenue Recognition, which clarifies certain existing accounting principles for the timing of revenue recognition and classification of revenues in
the financial statements. We recognize revenue beginning when there is persuasive evidence of an arrangement, delivery has occurred or services have been rendered, the fees are fixed and determinable and collection is reasonably assured. Our
subscriber revenues consist mainly of monthly recurring subscription fees. We recognize revenue ratably over the subscription period when the SAB 104 criteria are met. Revenues and associated expenses are deferred and recognized over the associated
service period. Associated expenses are deferred only to the extent of such deferred revenue.

In addition to the direct relationship that we have with the
majority of our paid subscribers, we also have indirect relationship agreements with Internet service providers (ISPs) and other companies whereby those companies customers are offered a co-branded subscription service. When the agreement
provides that we are the party responsible for providing the service, have control over the fees charged to customers and bear the credit risk, we record the gross amount billed as revenue in accordance with Emerging Issues Task Force 99-19 (EITF
99-19),Reporting Revenues Gross as a Principal Versus Net as an Agent. When the agreement provides that we receive a net payment from our co-branding partners based upon the number of their customers registered for our services, we record
the net amount received as revenue in accordance with EITF 99-19.

Allowances for Doubtful Accounts

We record an allowance for doubtful accounts based on our historical experience with bad debts. We periodically review and evaluate bad debt reserves held by the local
telephone companies and the third party that manages our billing relationship with the telephone companies. Judgment is required when we assess the realization of receivables, including assessing the probability of collection. Our allowance for
doubtful accounts totaled $472,000 as of March 31, 2007 and $574,000 as of June 30, 2006. Our allowance for doubtful accounts is correlated with our aggregate billings through the local telephone companies. The decrease in the allowance is
related to lower carrier reject rates and decreasing revenue.

Accounting for Income Taxes

We account for income taxes using the asset and liability method in accordance with SFAS 109,Accounting for Income Taxes, which requires the recognition of
deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and tax bases of the assets and liabilities. At March 31, 2007, we had net deferred tax assets of $7.3 million.
Due to the uncertainty of realizing these net deferred tax assets, we have recorded a valuation allowance for the entire balance of the deferred tax assets. Such uncertainty primarily relates to the potential for net operating loss carryforwards and
tax credits which begin to expire in 2010 and 2009, respectively, to be realized against future taxable income. We will continue to assess the likelihood of realization of these assets.

Loss Contingencies

We are subject to the possibility of various loss contingencies arising in the ordinary course of
business. We consider the likelihood of loss or impairment of an asset or the incurrence of a liability, as well as our ability to reasonably estimate the amount of loss, in determining loss contingencies. An estimated loss contingency is accrued
when it is probable that an asset has been impaired or a liability has been incurred and the amount of loss can be reasonably estimated. We regularly evaluate current information available to us to determine whether such accruals should be adjusted
and whether new accruals are required.



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Stock-Based Compensation

We account for stock-based compensation in accordance with the provisions of SFAS No. 123 (Revised 2004), Share-Based Payment (SFAS No. 123R). Under the fair value recognition provision of SFAS No. 123R, stock-based
compensation cost is estimated at the grant date based on the fair value of the award. We estimate the fair value of stock options granted using the Black-Scholes-Merton option pricing model and a single option award approach. The fair value is
amortized on a straight-line basis over the requisite service period of the awards, which is generally the vesting period.

Determining the appropriate
fair value of stock-based awards at the grant date requires judgment, including estimating stock price volatility, forfeiture rates and expected term. We compute expected volatility based on a combination of both historical volatility and
market-based implied volatility, as we believe that the combination provides a more accurate estimate of future volatility. The expected term represents the period of time that our stock-based awards are expected to be outstanding and is determined
based on historical experience of similar awards. Due to the inherent uncertainty in valuing awards for publicly-traded stock as of the grant date, given that such awards will be exercised, purchased or sold at indeterminate future dates, the actual
value realized by the recipients, if any, may vary significantly from the value of the awards estimated by us at the grant date.

Valuation of acquired
intangible assets

We have acquired intangible assets primarily via the acquisition of license agreements. These license agreements give us the right to
practice and use certain technologies in the fax, voice and internet telephony space. These assets are accounted for under Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets.
SFAS No. 142 requires us to record these assets at their fair value. Historically, we have used the cash purchase price at the time of acquisition as the best indicator of fair value. SFAS No. 142 also requires us to periodically evaluate
the carrying value of intangible assets to determine if an impairment loss should be recorded under SFAS No. 142. In accordance with Statement No. 142, an impairment loss shall be recognized if the carrying amount of an intangible
asset is not recoverable and its carrying amount exceeds its fair value. SFAS No. 144 outlines the factors which individually or in combination could trigger an impairment review as follows:



| |  |  | A significant decrease in the market price of a long-lived asset (asset group)
| | - |  | ------------------------------------------------------------------------------



| |  |  | A significant adverse change in the extent or manner in which a long-lived asset (asset group) is being used or in its physical condition
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------



| |  |  | A significant adverse change in legal factors or in the business climate that could affect the value of a long-lived asset (asset group), including an adverse
action or assessment by a regulator
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | An accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction of a long-lived asset (asset group)
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | A current-period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing
losses associated with the use of a long-lived asset (asset group)
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | A current expectation that, more likely than not, a long-lived asset (asset group) will be sold or otherwise disposed of significantly before the end of its
previously estimated useful life.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

If we determine that the carrying value of intangible assets may not be recoverable based upon the
existence of one or more of the above indicators of impairment, we would measure any impairment based on a projected discounted cash flow method using a discount rate commensurate with the risk inherent in our business.

Recent Accounting Pronouncements

In March 2006, the FASB issued FIN
No. 48, Accounting for Uncertainty in Income Taxes  an interpretation of FASB Statement No. 109, which clarifies the accounting for uncertainty in income taxes recognized in an enterprises financial statements in
accordance with FASB Statement No. 109, Accounting for Income Taxes. This Interpretation prescribes a threshold for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.
The Interpretation also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The effective date of this interpretation is the first fiscal year that begins after
December 15, 2006. We are currently evaluating the impact FIN 48 will have on our financial statements.

In September 2006, the Financial Accounting
Standards Board (FASB) issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (SFAS No. 157). This standard clarifies the principle that fair value should be based on the assumptions that
market participants would use when pricing an asset or liability. Additionally, it establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. SFAS No. 157 is effective for financial statements issued
for fiscal years beginning after November 15, 2007. We do not expect SFAS No. 157 to have a material impact on our financial condition or results of operations.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 158,  Employers Accounting for Defined Benefit Pension and Other Postretirement Plans an amendment of FASB
Statements No. 87, 88, 106, and 132(R) (SFAS No. 158). This standard requires employers to recognize the underfunded or overfunded status of a defined benefit postretirement plan as an asset or liability in its statement of
financial position and to recognize changes in the funded status in the year in which the changes occur through accumulated other comprehensive income. Additionally, SFAS No. 158 requires employers to measure the funded



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status of a plan as of the date of its year-end statement of financial position. The new reporting requirements and related new footnote disclosure rules of
SFAS No. 158 are effective for fiscal years ending after December 15, 2006. The new measurement date requirement applies for fiscal years ending after December 15, 2008. We do not expect SFAS No. 158 to have a material impact on
our financial condition or results of operations.

In September 2006, the SEC issued Staff Accounting Bulletin (SAB) No. 108, Considering
the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements, providing guidance on how prior year misstatements should be taken into consideration when quantifying misstatements in current year
financial statements for purposes of determining whether the current years financial statements are materially misstated. SAB No. 108 is effective for fiscal years ending on or after November 15, 2006, and accordingly, we have
adopted SAB No. 108 beginning in fiscal year 2007. The adoption of SAB 108 did not have an impact on our financial condition or results of operations.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and LiabilitiesIncluding an amendment of FASB Statement No. 115(SFAS 159).SFAS 159 permits entities to
choose to measure certain financial assets and liabilities at fair value (the fair value option). Unrealized gains and losses, arising subsequent to adoption, are reported in earnings. We do not expect SFAS No. 159 to have a
material impact on our financial condition or results of operations.

Results of Operations

The following tables set forth our statement of operations data for each of the periods indicated (in thousands).



|                                |  |                             |        |   |                            |   |       |      |  |   |        |   |  |   |        |  
|------------------------------- |  | --------------------------- | ------ | - | -------------------------- | - | ----- | ---- |  | - | ------ | - |  | - | ------ | -
|                                |  | Three Months EndedMarch 31, |        |   | Nine Months EndedMarch 31, |  
|                                |  | 2007                        |        |   | 2006                       |   |       | 2007 |  |   | 2006   |  
|Statement of Operations Data:   |  |                             |        |   |                            |   |       |      |  |   |        |   |  |   |        |  
|Revenues                        |  | $                           | 6,230  |   |                            | $ | 8,801 |      |  | $ | 19,673 |   |  | $ | 28,910 |  
|Cost of sales                   |  |                             | 2,257  |   |                            |   | 3,125 |      |  |   | 6,676  |   |  |   | 10,275 |  
|                                |  |                             |        |   |                            |   |       |      |  |   |        |   |  |   |        |  
|Gross profit                    |  |                             | 3,973  |   |                            |   | 5,676 |      |  |   | 12,997 |   |  |   | 18,635 |  
|Operating expenses:             |  |                             |        |   |                            |   |       |      |  |   |        |   |  |   |        |  
|Sales and marketing             |  |                             | 2,347  |   |                            |   | 1,770 |      |  |   | 5,381  |   |  |   | 4,802  |  
|Research and development        |  |                             | 1,857  |   |                            |   | 1,687 |      |  |   | 5,266  |   |  |   | 5,031  |  
|General and administrative      |  |                             | 3,136  |   |                            |   | 3,143 |      |  |   | 9,899  |   |  |   | 8,121  |  
|Impairment of long-lived assets |  |                             |       |   |                            |   |      |      |  |   |       |   |  |   | 243    |  
|                                |  |                             |        |   |                            |   |       |      |  |   |        |   |  |   |        |  
|Total operating expenses        |  |                             | 7,340  |   |                            |   | 6,600 |      |  |   | 20,546 |   |  |   | 18,197 |  
|                                |  |                             |        |   |                            |   |       |      |  |   |        |   |  |   |        |  
|Operating income (loss)         |  |                             | (3,367 | ) |                            |   | (924  | )    |  |   | (7,549 | ) |  |   | 438    |  
|Interest income                 |  |                             | 766    |   |                            |   | 659   |      |  |   | 2,363  |   |  |   | 1,741  |  
|                                |  |                             |        |   |                            |   |       |      |  |   |        |   |  |   |        |  
|Income loss before income taxes |  |                             | (2,601 | ) |                            |   | (265  | )    |  |   | (5,186 | ) |  |   | 2,179  |  
|Income tax expense              |  |                             |       |   |                            |   | 156   |      |  |   |       |   |  |   | 3,085  |  
|                                |  |                             |        |   |                            |   |       |      |  |   |        |   |  |   |        |  
|Net loss                        |  | $                           | (2,601 | ) |                            | $ | (421  | )    |  | $ | (5,186 | ) |  | $ | (906   | )
|                                |  |                             |        |   |                            |   |       |      |  |   |        |   |  |   |        |  

Three Months Ended March 31, 2007 and March 31, 2006

Revenues. Revenues were $6,230,000 for the three months ended March 31, 2007, compared to $8,801,000 for the three months ended March 31, 2006, a
decrease of $2,571,000 or 29%. Subscription revenues were $6,200,000 for the three months ended March 31, 2007, representing 99% of revenues, compared to $8,752,000 for the three months ended March 31, 2006, representing 99% of revenues, a
decrease of $2,552,000, or 29%. The decrease in our revenues was attributable primarily to a decrease in the number of paying subscribers from approximately 763,000 at March 31, 2006 to approximately 637,000 at March 31, 2007. The decrease
in subscribers is driven primarily from the migration of dial up users to broad band which is a trend we expect to continue. In addition, our average revenue per user (ARPU) decreased as we have a higher percentage of our subscribers
from our indirect channel distribution arrangements. We record revenue from our indirect channel distributors on a gross or net basis depending on the facts of the agreement. Revenues from our indirect channel distributors for the three months ended
March 31, 2007, was $700,000 or 11% of revenues compared to $700,000 or 8% of revenues for the same period last year.



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Cost of sales.Cost of sales was $2,257,000 for the three months ended March 31, 2007, compared to $3,125,000
for the three months ended March 31, 2006, a decrease of $868,000, or 28%. The decrease in cost of sales is primarily related to the decrease in the number of subscribers.

Sales and marketing. Sales and marketing expenses were $2,347,000, or 38% of revenues, for the three months ended March 31, 2007, compared to $1,770,000, or 20% of revenues, for the three months ended
March 31, 2006, an increase of $577,000, or 33%. The increase as a percentage of total revenue is driven by the quarter over quarter decline in revenue as our direct to consumer dial up subscribers migrate to broadband services and we
transition our business toward indirect channel distributors. We also had increased marketing expenses as we promoted our direct to consumer free beta products through various ad based services. We expect to incur higher marketing expenses in coming
quarters as we continue to promote new products and new product features and enhancements in the direct to consumer and carrier channels. We are committed to investing in our Sales and Marketing functions as we migrate a greater percentage of our
business toward indirect channel distributors with landline and mobile operators while continuing to build product usage and add new subscribers in the direct-to-consumer channel.

Research and development. Research and development expenses were $1,857,000, or 30% of revenues, for the three months ended March 31, 2007, compared to $1,687,000, or 19% of revenues, for the three months
ended March 31, 2006. The 11% increase as a percentage of total revenue is driven by the quarter over quarter decline in revenue as our direct to consumer dial up subscribers migrate to broadband services and we transition our business toward
indirect channel distributors. Over the last four months we have launched six new products and believe it is essential to have a strong research and development team as we continue to develop new products and add additional features and
functionality in the direct channel and migrate our business toward indirect channel distribution arrangements with landline, mobile carriers and web portals, while continuing to strategically invest in the direct-to-consumer channel.

General and administrative. General and administrative expenses were $3,136,000, or 50% of revenues for the three months ended March 31, 2007, compared to
$3,143,000, or 36% of revenues, for the three months ended March 31, 2006, a decrease of $7,000. Legal fees related to the litigation with j2 Global and Catch Curve were approximately $800,000 for the three months ended March 31, 2007. As
a result of the settlement, these fees will not be recurring in future quarters.

Net loss.Net loss was $2,601,000 for the three months ended
March 31, 2007, compared to net loss of $421,000 for the three months ended March 31, 2006. This net loss was primarily the result of reduced revenues as we shift our focus toward indirect distributor arrangements and our preparation for
shifting our company into the indirect channel. Other contributing factors consisted of increased payroll and related costs, litigation fees, and stock based compensation charges.

Nine Months Ended March 31, 2007 and March 31, 2006

Revenues. Revenues were $19,673,000 for
the nine months ended March 31, 2007, compared to $28,910,000 for the nine months ended March 31, 2006, a decrease of $9,237,000, or 32%. Subscription revenues were $19,535,000 for the nine months ended March 31, 2007, representing
99% of revenues, compared to $28,528,000 for the nine months ended March 31, 2006, representing 99% of revenues, a decrease of $8,993,000, or 32%. The decrease in our revenues was attributable primarily to a decrease in the number of paying
subscribers from approximately 763,000 at March 31, 2006 to approximately 637,000 at March 31, 2007. The decrease in subscribers is driven primarily from the migration of dial up users to broad band which is a trend we expect to continue.
In addition, our average revenue per user (ARPU) decreased as we have a higher percentage of our subscribers from our indirect channel distribution arrangements. We record revenue from our indirect channel distributors on a gross or net
basis depending on the facts of the agreement. Revenues from our indirect channel distributors for the nine months ended March 31, 2007, were $2,280,000 or 12% of revenues compared to $1,900,000 or 7% of revenues for the same period last year.
During the first quarter of the current fiscal year we refined our assumptions for the amortization of deferred revenue and the associated costs. The effect on revenue of refining these assumptions, which was treated as a change in estimate under
U.S. GAAP, was a reduction in revenue of $594,000. These refined assumptions also reduced cost of sales by $214,000 and increased net loss by $380,000, or $0.02 per share. The change in estimate relates to more timely and accurate information made
available by our third party billing provider.

Cost of sales.Cost of sales was $6,676,000
for the nine months ended March 31, 2007, compared to $10,275,000 for the nine months ended March 31, 2006, a decrease of $3,599,000, or 35%. The decrease in cost of sales is primarily related to the decrease in the number of subscribers
and a credit of $574,000 from one of our telecommunications carriers which we received in the 2ndquarter of fiscal
2007. The carrier was charging us for more lines than we had contracted to rent over an eleven month period beginning in January, 2006. The carrier agreed to credit our account for the overcharges and apply the credit to future bills.

Sales and marketing. Sales and marketing expenses were $5,381,000 or 27% of revenues, for the nine months ended March 31, 2007, compared to $4,802,000, or
17% of revenues, for the nine months ended March 31, 2006. The 10% increase as a percentage of total revenue is driven by the quarter over quarter decline in revenue as our direct to consumer dial up subscribers migrate to broadband services
and we transition our business toward indirect channel distributors. We also had increased marketing expenses as we promoted our direct to consumer free beta products through various ad based services. We expect to incur higher marketing expenses in
coming quarters as we continue to promote new products and new product features and enhancements in the direct to consumer and carrier channels. We are committed to investing in our Sales and Marketing functions as we migrate a greater percentage of
our business toward indirect channel distributors with landline and mobile operators while continuing to build product usage and add new subscribers in the direct-to-consumer channel.



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Research and development. Research and development expenses were $5,266,000, or 27% of revenues, for the nine
months ended March 31, 2007, compared to $5,031,000, or 17% of revenues, for the nine months ended March 31, 2006, an increase of $235,000, or 5%. The 10% increase as a percentage of total revenue is driven by the quarter over quarter
decline in revenue as our direct to consumer dial up subscribers migrate to broadband services and we transition our business toward indirect channel distributors. Over the last four months we have launched six new products and believe it is
essential to have a strong research and development team as we continue to develop new products and add additional features and functionality in the direct channel and migrate our business toward indirect channel distribution arrangements with
landline, mobile carriers and web portals, while continuing to strategically invest in the direct-to-consumer channel.

General and administrative.
General and administrative expenses were $9,899,000, or 50% of revenues for the nine months ended March 31, 2007, compared to $8,121,000, or 28% of revenues, for the nine months ended March 31, 2006, an increase of $1,778,000, or 22%. The
increase in general and administrative expenses was due primarily to increased legal fees, payroll and related expenses, and stock based compensation charges. Legal fees related to the litigation with j2 Global and Catch Curve were approximately
$2,700,000 for the nine months ended March 31, 2007. As a result of the settlement, these fees will not be recurring in future quarters.

Impairment loss. During the first quarter of the fiscal year ended June 30, 2006, we determined, based on an analysis of future cash flows, that our investment in and receivable from a company in which we had a minority interest
was other than temporarily impaired. Accordingly, we recorded an impairment loss in the amount of $253,000, which was partially offset by a $10,000 gain on the sale of an asset that had previously been written off.

Income tax provision. We recognized an income tax provision for the nine months ended March 31, 2006 of $3,085,000. No tax benefit was derived from the net
loss recognized during the nine months ended March 31, 2007 due to the valuation allowance established to offset our deferred tax assets. Total deferred tax assets amount to $7.3 million and have been fully offset by a valuation allowance
reflecting the fact that we have not determined that it is more likely than not that we will be able to use our deferred tax assets to reduce income taxes. We will continue to assess the likelihood of realization of our net deferred tax assets and
may adjust the balance in the future accordingly.

Net loss.Net loss was $5,186,000 for the nine months ended March 31, 2007, compared to net
loss of $906,000 for the nine months ended March 31, 2006. This net loss was primarily the result of reduced revenues as we shift our focus toward indirect distributor arrangements and our preparation for shifting our company into the indirect
channel. Other contributing factors consisted of increased payroll and related costs, litigation fees, stock based compensation charges, and a change in estimate described under Revenues above. The net loss was reduced by the credit
described in the Cost of sales section above.

Liquidity and Capital Resources

At March 31, 2007, our principal sources of liquidity were cash and cash equivalents of $19,464,000, marketable securities of $35,939,000, and accounts receivable
net of allowance for doubtful accounts of $2,576,000. Since our initial public offering our working capital and capital expense requirements have been funded with cash flow provided from operations. We believe our current cash reserves are adequate
to cover anticipated losses over the next fiscal year as we migrate our business toward the indirect channel while continuing to strategically invest in our direct-to-consumer channel. We do not expect to return to profitability until the first half
of fiscal 2009 and we do not expect cash flow from operations to be positive in future periods until we return to profitability. We reexamine our cash requirements periodically in light of changes in our business.

Cash and cash equivalents and marketable securities decreased from $60.9 million at June 30, 2006 to $55.4 million at March 31, 2007. This decrease is
primarily due to settlement of the j2 and Catch Curve litigation for $4 million, cash used in operating activities of $1.1 million, and purchases of property and equipment of $680,000, partially offset by $1.1 million of sales of marketable
securities in excess of purchases.

Off-Balance Sheet Arrangements

We have not entered into any off-balance sheet arrangements.

Franchise Tax Board Audit

In May 2006, we were notified by the California Franchise Tax Board that our research and development credits for the taxable year ended June 30, 2004, would be
under examination. As of the date of this filing, the examination is nearing completion. The Franchise Tax Board has recommended a reduction of our carryforward research credits by approximately $325,000. We intend to appeal the recommendation. Due
to the valuation allowance recorded against our deferred tax assets, the reduction of the credit carryforward will not affect CallWaves income tax provision, net loss, or net loss per share.

Internal Revenue Service Audit

In October 2006, we were notified by
the Internal Revenue Services that our income tax return for the year ended June 30, 2004, would be under examination. As of the date of this filing, the examination is nearing completion and we do not expect a material adjustment.



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|ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|------- | ----------------------------------------------------------

Foreign currency exchange risk. We do not currently do any business denominated in foreign currencies and, therefore, are not subject to any significant foreign currency exchange risk.

Interest rate sensitivity.We had cash and cash equivalents totaling $19.5 million and marketable securities totaling $35.9 million at March 31, 2007, and
cash and cash equivalents totaling $24 million and marketable securities totaling $36.9 million at June 30, 2006. Cash and cash equivalents were held for working capital purposes in depository accounts at FDIC-regulated banking institutions.
Marketable securities consist of investment grade securities including auction-rate securities, which carry interest or dividend rates that reset every seven to 28 days, corporate bonds, and government and agency securities. We do not enter into
investments for trading or speculative purposes. Due to our ability to liquidate these investments, we believe that we do not have any material exposure to changes in the fair value of our cash and cash equivalents or marketable securities as a
result of changes in interest rates. Declines in interest rates, however, will reduce our future interest income. If interest rates were to decline by 3.0% as compared to the rates at March 31, 2007, our interest income would decrease
approximately $410,000 on a quarterly basis based on the outstanding balance of our marketable securities and money market funds at March 31, 2007. A decline in market value of 3.0% would reduce the value of our cash equivalents and marketable
securities by approximately $1.1 million.



|ITEM 4. | CONTROLS AND PROCEDURES
|------- | -----------------------

(a) Evaluation of disclosure controls
and procedures.

As of the end of the period covered by this report, under the supervision and with the participation of management, including our Chief
Executive Officer and Chief Financial Officer, management evaluated the effectiveness of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended. Based on
that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of March 31, 2007.

(b) Changes in internal controls over financial reporting.

There have not been any changes in our internal control
over financial reporting during the fiscal quarter ended March 31, 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

(c) Inherent Limitations on Effectiveness of Controls.

The
Companys management, including our Chief Executive Officer and Chief Financial Officer, believes that our disclosure controls and procedures and internal control over financial reporting are effective at a reasonable assurance level. However,
the Companys management does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can
provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered
relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These
inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by
collusion of two or more people or by management override of the controls. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will
succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with policies or procedures may deteriorate. Because of the inherent
limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.



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PART IIOTHER INFORMATION



|ITEM 1. | LEGAL PROCEEDINGS
|------- | -----------------

As most recently reported in the Quarterly
Report on Form 10-Q for the quarter ended December 31, 2006, as filed on February 13, 2007, CallWave was involved in a dispute with Catch Curve, Inc., a Delaware corporation, and j2 Global Communications, a Delaware corporation
(collectively j2 Global). The matters concerned allegations that CallWaves operations infringed certain patents of j2 Global, and were the subject of two actions pending in the United States District Court for the Central District
of California (Action Nos. 04-7068 and 05-4819).

Effective March 13, 2007, CallWave and j2 Global entered into a Patent License and Settlement
Agreement (the Agreement). In the Agreement, CallWave and j2 Global agreed to resolve all of j2 Globals outstanding patent infringement claims. Under the terms of the Agreement, CallWave has agreed to pay $4 million to j2 Global
for a fully paid-up, nonexclusive license to use the Licensed Patents (as that term is defined in the Agreement) for non-fax services. In addition, CallWave will pay a running royalty of at least 10% for a non-exclusive license to use the Licensed
Patents for fax services. CallWave and j2 Global have agreed to dismiss all pending litigation.



|ITEM 1A. | RISK FACTORS
|-------- | ------------

In addition to the other information set forth in
this report, you should carefully consider the factors set forth under the caption Special Note Regarding Forward Looking Statements in Part II, Item 7, of our Annual Report on Form 10-K, for our fiscal year ended June 30,
2006, the factors set forth under the caption Risks Related To Our Business in Part II, Item 7A, of our Annual Report on Form 10-K, for our fiscal year ended June 30, 2006, and the factors set forth under the caption Risk
Factors in Part II, Item 1A, of our Quarterly Report on Form 10-Q, for the period ended December 31, 2006. The risks discussed in our Annual Report on Form 10-K and our Quarterly Report on Form 10-Q could materially affect
our business, financial condition and future results. The risks described in our Annual Report on Form 10-K and in our Quarterly Report on Form 10-Q are not the only risks facing us. Additional risks and uncertainties not currently known to us or
that we currently deem to be immaterial also may materially and adversely affect our business, financial condition or operating results. Other than discussed below, there have been no material changes to the Risk Factors as previously disclosed in
our Form 10-K for the fiscal year ended June 30, 2006 and in our Form 10-Q for the quarter ended December 31, 2006.

We rely upon sufficient
availability of telephone numbers.

Our future success will depend in part upon our ability to procure and maintain sufficient quantities of telephone
numbers in area codes where our subscribers are located at costs we can afford. The ability of telecommunications carriers to provide us with telephone numbers to be used in conjunction with our services depends on applicable regulations, the
practices of telecommunications carriers that provide telephone numbers, and the level of demand for new telephone numbers. In addition, the Federal Communications Commission, or FCC, has regulations concerning numbering resource utilization. If
CallWave does not sufficiently utilize the numbers assigned to it, it may have to relinquish control of those unused numbers. Furthermore, the FCC and state public utility commissions periodically review numbering utilization, and may in the future
propose additional changes to regulations or interpret existing regulations that affect number assignment and the availability of numbers for, or the applicability of number portability requirements to, our services. Failure to have access to
sufficient telephone numbers in a timely and cost-effective manner, or the loss of use of numbers we have previously accessed or may access, could prevent us from entering some markets or slow our growth in the markets in which we currently sell our
services.

Future legislation, regulation, or legal decisions affecting the Internet, Internet telephony or IP-enabled services could restrict our
business, prevent us from offering our services or increase our cost of doing business.

We believe that, as a matter of regulatory classification, our
offerings qualify as enhanced or information services and that we are not currently subject to direct regulation by the FCC or generally by state public utility commissions. However, there is a risk that state or federal regulators could rule that
some features of our services are telecommunications services subject to common carrier regulations. There is also the potential, even if state and federal regulators were to confirm that our offerings are not telecommunications services,
that state or federal regulators might seek to impose regulations on our offerings.

The FCC has not, to date, adopted a comprehensive regulatory framework
for IP-enabled services or attempted generally to classify IP-enabled services under the Communications Act of 1934, instead issuing only a small number of ad hoc decisions concerning whether particular offerings are telecommunications,
telecommunications services, and or information/enhanced services. Nonetheless, the FCC has begun imposing regulatory obligations upon interconnected VoIP services, including the obligation to offer enhanced 911 service, to comply with
the same CALEA requirements that apply to providers of telecommunications services, to contribute to the federal Universal Service Fund and, most recently, to comply with regulations affecting use of Customer Proprietary Network Information
("CPNI"). Apart from the specific regulatory obligations that the FCC has imposed upon providers of interconnected VoIP services, there are few laws, regulations or rulings that specifically address access to or commerce on the Internet,
including the provision of Internet protocol-based telephony and other IP-enabled services. We are unable to predict the impact, if any, that future legislation, regulations or legal decisions may have on our business. However, the growth in the
market for IP-based telephony and other IP-enabled communications, and the popularity of these services, along with other regulatory objectives, such as ensuring adequate funding levels for the federal Universal Service Fund create the risk that
governments and agencies



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increasingly will seek to regulate services such as our current offerings, including the potential for findings that such regulations apply retroactively.
Many legislative and regulatory actions are underway or are being contemplated by federal and state authorities, including the FCC and various state regulatory agencies. For example:



| |  |  | On March 10, 2004, the FCC released a notice of proposed rulemaking (Docket 04-36) and sought public comment regarding the regulatory classification, rights
and obligations of services supported by IP technologies. The FCC has yet to adopt a general regulatory framework for IP-enabled services or address the majority of the issues raised in this proceeding.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | On April 21, 2004, the FCC released a narrow declaratory ruling finding that certain Internet protocol telephony services are telecommunications services upon
which interstate access charges may be assessed. Prior to this decision, the FCC had never ruled that a specific service relying on Internet-protocol technology was a telecommunications service. On June 30, 2006, the FCC released an order
holding that menu-driven prepaid calling cards, and prepaid calling cards that use IP transport to deliver all or a portion of the call embody telecommunications services, and these prepaid calling card providers qualify as telecommunications
carriers that are subject to, among other things, Universal Service Fund contributions based on their interstate revenues as well as intrastate and interstate access charges. These rulings illustrate that certain Internet-protocol based services may
become subject to costs and regulations that, previously, were not thought to be applicable. Neither of these rulings, however, is likely to have any direct effect on us in the near future.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | On November 12, 2004, the FCC released an order preempting a September 11, 2003 order of the Minnesota Public Utilities Commission (Minnesota
Order). In the preempted Minnesota Order, the Minnesota Commission had asserted regulatory jurisdiction over Vonages DigitalVoice service and ordered Vonage to comply with all state statutes and regulations related to the offering of
telephone service in Minnesota. The principal basis for FCC preemption was the finding that there was no practical means of directly or indirectly identifying the geographic location of the Digital Voice subscriber. Although the FCC did not preempt
any specific state regulations or orders apart from the Minnesota Order, it explained that, to the extent that other VoIP services are not the same as Vonages but share similar basic characteristics, we believe it highly unlikely that
the Commission would fail to preempt state regulation of those services to the same extent. The FCC, however, did not determine whether DigitalVoice or any other IP-enabled service is an information or telecommunications service, and thus the
regulatory classification of these services under the Act remained an open issue. Moreover, the FCC subsequently clarified that an interconnected VoIP provider with the capability to track the jurisdictional confines of its customer calls depending
upon the customers geographic location would likely not qualify for the preemptive effects of the Vonage Order, and that state commissions may be free to regulate such offerings. On March 21, 2007, the U.S. Court of Appeals for the Eighth
Circuit upheld the FCC's preemption order. Notably, however, on January 18, 2007, the U.S. District Court for the Western District of Missouri ruled that, as of that date, the FCC has not preempted regulation of all VoIP services, and thus
states retain the jurisdiction to at least regulate interconnected VoIP services that fall outside of the scope of the Vonage order. Specifically, the district court rejected a Comcast request for an injunction of the Missouri Public Service
Commissions proceeding to ascertain whether and how to regulate Comcasts fixed VoIP services. In light of these developments, state commissions may increasingly seek to regulate interconnected VoIP services that can be characterized as
intrastate.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | On June 3, 2005, the FCC ordered all providers of interconnected VoIP services to offer enhanced 911 services as a condition of providing service, and to
notify all consumers regarding the circumstances under which E911 may not be available or may be limited by comparison to traditional E911 service. The FCC has requested comment on, among other topics, whether these requirements should be expanded
or imposed upon other providers of IP-enabled services. The Commission did not rule whether such offerings are telecommunications or information services.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | On September 23, 2005, the FCC released an order reclassifying wireline broadband Internet access services as information services, thereby placing wireline
broadband Internet access services within the same general regulatory framework as cable modem services. Similarly, on November 7, 2006, and march 23, 2007, the FCC released orders declaring Broadband over Power Line (BPL)-enabled
Internet access service and wireless broadband Internet access service, respectively, to be information services. As information services, wireline, wireless, and BPL-enabled broadband Internet access, like cable modem service, no longer are subject
to regulation under Title II of the Communications Act of 1934, as amended, or the FCCs Computer Inquiry rules, but are subject to specific obligations imposed under Title I of the Act. The Commission also permitted, in March 2006, a petition
of Verizon for forbearance of federal Title II and Computer Inquiryregulation of its broadband services to be deemed granted by operation of law, an action which is now subject to appeal. Further, petitions for forbearance
seeking relief similar to that deemed granted to Verizon were filed by AT&T, Sprint, Embarq, and other ILECs in 2006, and the Commission must act on these various petitions in the second half of 2007. These FCC actions, and the grant
of the pending petitions for forbearance, could potentially enable ILECs to (1) refuse to permit subscribers to their broadband transmission services to use our enhanced services, (2) charge higher rates for underlying broadband
transmission service to subscribers to our enhanced services, or (3) bundle enhanced services that are similar to our enhanced services with their broadband transmission services at such a rate that it becomes economically unfeasible for us to
compete with the ILEC. If one or more ILECs take any of those actions with explicit or tacit permission from the FCC, then it could have a material adverse impact upon our profitability and results of our operations.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | On June 27, 2006, the FCC issued a decision finding that providers of interconnected VoIP services offer telecommunications as defined
by the Communications Act and must therefore contribute to the federal Universal Service Fund. The FCC based its decision on the fact that these offerings allow end users to place calls to (and receive calls from) other end users on the public
switched telephone network or that are served by other interconnected VoIP providers and to transmit information of their own choosing to such other end users. The FCC declined to rule whether such offerings qualify as telecommunications
services or as information services. This decision makes it more likely that the FCC will ultimately conclude that other IP-enabled services are telecommunications and that their providers must contribute to the federal
Universal Service Fund where such services enable subscribers to transmit information of their own choosing between points of their own choosing.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | On March 1, 2007, the FCC clarified that, where a local exchange carrier wins a customer from a provider of interconnected VoIP services, the telephone number,
upon the customers request, should be ported to the local exchange carrier. The Commission reemphasized that other concerns about the porting obligations of interconnected VoIP service providers will be addressed in its IP-Enabled Services
proceeding. Although the FCC declined to reach the question of whether interconnected VoIP is a telecommunications service, the agencys clarification treats, for the purposes of portability, providers of interconnected VoIP
services like resellers of telecommunications services rather than end users of such services.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | On April 2, 2007, the FCC adopted an order establishing new rules designed to safeguard the confidentiality of customer proprietary network information
("CPNI"). The new rules focus on protection of unlawful disclosure and sale of CPNI made possible through pretexting, the use of passwords to protect against unauthorized disclosure of CPNI, procedures when unauthorized disclosure occurs, and annual
certification requirements. These additional regulations complement the Commission's existing CPNI rules which generally limit the collection and use of CPNI by wireline and wireless carriers. The FCC extended its pre-existing rules, as well as the
new regulations, to interconnected VoIP providers invoking its ancillary regulatory authority under Title I of the Communications Act of 1934, as amended. Once again, the Commission declined to reach the question of whether interconnected VoIP is a
telecommunications service.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The interconnected VoIP services that are the subject of the decisions referenced above are
offered to the public as substitutes for, or as substantially equivalent to, existing telecommunications services. In contrast, our customers could not use our service unless they are also separately receiving telecommunications services from their
own service provider. Certain decisions adopted by state commissions before the FCC issued its preemption order suggested an increased interest by some state commissions in regulating services that may be perceived as the functional equivalent of
local phone service. If state regulators attempt to regulate the enhanced services that we provide or determine that the enhanced services that we provide are currently subject to their regulatory provisions, then we may be faced with substantially
increased regulatory burdens and costs.

Regulatory proceedings, legislative efforts and adjudications, including but not limited to some of those
described above, have created a certain level of uncertainty regarding the regulatory classification of some of our services and features. Future regulatory actions may lead to the imposition of additional regulatory obligations and requirements on
us in the provision of our services and features, including but not limited to certification requirements, interstate or intrastate access charges, regulatory fees, payments to support state and federal universal service-funds, taxes related to
Internet or IP-enabled communications, requirements to provide free access to certain users, regulations based on encryption concerns, consumer protection requirements and certain minimum service levels. We could conceivably become subject to
requirements and obligations not only at the federal level, but also in any of the states in which we have customers or from which third persons initiate communications to call our customers, as well as in any of those jurisdictions in which
facilities exist or activities occur which support our offerings. Further, as we expand into additional lines of business or make new service offerings, we could become subject to existing or future regulation or other legal requirements, including
but not limited to those which apply to telecommunications services and the providers of such services. The impact of federal or state legislative, regulatory, or adjudicatory actions or requirements may apply not only prospectively but conceivably
retroactively and could result in an increase in our costs, adversely affect how we conduct our business, and adversely affect our financial condition and results of operations, and restrict our growth potential.

Certain decisions adopted by state commissions before the FCC issued the preemption order discussed above suggested an increased interest by some state commissions in
regulating services that may be perceived as the functional equivalent of local phone service. If state regulators attempt to regulate the enhanced services that we provide or determine that the enhanced services that we provide are currently
subject to their regulatory provisions, then we may be faced with substantially increased regulatory burdens and costs.



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|ITEM 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
|------- | -----------------------------------------------------------

Sales of Unregistered Securities

None.

Use of Proceeds

Not applicable.



|ITEM 3. | DEFAULTS UPON SENIOR SECURITIES
|------- | -------------------------------

Not applicable.



|ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
|------- | ---------------------------------------------------

None.



|ITEM 5. | OTHER INFORMATION
|------- | -----------------

None



|ITEM 6. | EXHIBITS
|------- | --------



|              |  |                                                                                                                                                                            
|------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                                
|3.1(1)        |  | Amended and Restated Certificate of Incorporation of the Registrant.                                                                                                       
|              | 
|3.2(2)        |  | Certificate of Amendment to Amended and Restated Certificate of Incorporation.                                                                                             
|              | 
|3.3(5)        |  | Certificate of Amendment to Amended and Restated Certificate of Incorporation.                                                                                             
|              | 
|3.4(3)        |  | Bylaws of the Registrant.                                                                                                                                                  
|              | 
|10.1(4)       |  | Employment Agreement dated November 20, 2006 by and between Mark Stubbs and the Registrant.                                                                                
|              | 
|31.1          |  | Certification of Chief Executive Officer pursuant to Securities Exchange Act Rules 13a-14 and 15d-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|              | 
|31.2          |  | Certification of Chief Financial Officer pursuant to Securities Exchange Act Rules 13a-14 and 15d-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|              | 
|32.1          |  | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                         
|              | 
|32.2          |  | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                         

---

|(1) | Previously filed in the Registrants Registration Statement Amendment No. 5 on Form S-1 (File No. 333-115438) filed on September 27, 2004 and incorporated herein
by reference.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Previously filed in the Registrants Quarterly Report on Form 10-Q filed on February 14, 2006 and incorporated herein by reference.
|--- | -----------------------------------------------------------------------------------------------------------------------------------

|(3) | Previously filed in the Registrants Registration Statement on Form S-1 (File No. 333-115438) on May 13, 2004 and incorporated herein by reference.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Previously filed in the Registrants Current Report on Form 8-K filed on November 27, 2006 and incorporated herein by reference.
|--- | --------------------------------------------------------------------------------------------------------------------------------

|(5) | Previously filed in the Registrants Quarterly Report on Form 10-Q filed on February 13, 2007 and incorporated herein by reference.
|--- | -----------------------------------------------------------------------------------------------------------------------------------



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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this
report to be signed on its behalf by the undersigned thereunto duly authorized.



|                   |  |                 |  |                                                                     
|------------------ |  | --------------- |  | --------------------------------------------------------------------
|                   |  | CALLWAVE, INC.,
|                   |  |                
|Date: May 14, 2007 |  | By:             |  | /s/ David F. Hofstatter                                             
|                   |  |                 |  | David F. Hofstatter,                                                
|                   |  |                 |  | President and Chief Executive Officer                               
|                   |  |                
|Date: May 14, 2007 |  | By:             |  | /s/ Mark Stubbs                                                     
|                   |  |                 |  | Mark Stubbs                                                         
|                   |  |                 |  | Chief Financial Officer (principal financial and
accounting officer)



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